UK retail giant Tesco recently announced its first move into China, an emerging market that has grown in stature and potential. It is often touted as ‘the next big thing’ but China is a tough nut to crack, and new players such as Tesco can learn a lot from the early international movers, as Kate Barker found out.
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Helped by factors such as demographic shifts and the easing of regulatory hurdles, the Chinese retail market has already attracted the attention of Wal-Mart and Carrefour, and where they go, other retailers are bound to follow. Last week it was the turn of UK retail giant Tesco, which had been considering a move for some time and has finally secured entry to the Chinese market via a 50/50 joint venture agreement with Chinese food and beverage producer Ting Hsin, whose subsidiary Ting Cao owns the Hymall chain of stores in China.
Tesco is to spend £140m (US$260m) on the purchase of 50% of Ting Cao’s equity in Hymall, a chain of 25 hypermarkets averaging 8,300 sq. m. in size and mostly situated in high quality shopping mall developments. According to Tesco CEO Sir Terry Leahy, “China is one of the largest economies in the world with tremendous forecast growth and a market we have researched extensively over the last three years.”
There exists great potential for foreign retailers in China, where the fundamentals for growth in the retail market are in place, according to Johanna Waterous, a director of management consultancy firm McKinsey. As she told IGD’s Global Retail conference recently, the structure of the market and consumer behaviour in China is leapfrogging western development, with the importance of convenience stores taking off despite the relatively recent emergence of the format.
One of the fundamentals for growth is the easing of regulatory restrictions on foreign retailers. Following China’s accession to the World Trade Organisation in December 2001, the country is moving to ease its restrictions on foreign retailers, and has vowed to abandon its joint-venture requirements before the end of this year. The Chinese government has also said it will end restrictions on the location of foreign-owned retail outlets and the number of stores allowed. These favourable shifts in regulation may tempt some international retailers into making a move into China, as the restrictions in the past had proved a major stumbling block.
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By GlobalDataA recent survey by business analysts KPMG found that joint ventures in China had indeed fallen out of favour in recent years. Much of this may be to do with the persistent problems in China over protecting a company’s intellectual property – an issue which ranks at the very top of the list of areas of major concern in the survey. It is also partly informed by a more relaxed attitude on the part of the Chinese government, which had previously insisted on the joint venture/partnership structure for much of the time that Western investment has been permitted.
JVs fraught with difficulty
Of those businesses from the KPMG survey that were already in China, 37% are in some form of JV. However, only 19% see it as the best way forward for their business. The preferred way forward is to be a Wholly Owned Foreign Enterprise (WOFE).
Mark Baillache, head of food manufacturing at KPMG, said: “Any company planning to establish operations in China really should sit up and take notice of these findings. The attraction of the JV approach is on the wane. At one time, it was the only way to enter China and even after WOFEs were permitted in this sector, conventional wisdom held that a local partner was a necessity. However, the view from inside is now very different and the popularity of the WOFE approach is soaring. It is actually a more popular approach with the companies already in China – who have likely seen many failed JVs up close – than with the companies planning to enter China. It’s a theme which the latter group would do well to take note of.”
Different JVs succeed or fail for different reasons. However, common problems include a divergence of goals, disagreements on how to expand the business and disputes over management style and roles.
Intellectual property a concern
However, another well publicised problem within JV agreements has been the difficulty that foreign entrant firms have in protecting their own IP. For example, direct copies of companies’ products, logos and production processes have all come to light after foreign firms have entered into partnership with a local business.
Perhaps unsurprisingly, IP was named as a key concern by 73% of respondents – well ahead of the problems around sourcing decent market information (57%), the repatriation of funds (53%) and import/export procedures (52%). Summing up the IP concerns of many businesses in China, one president of an FMCG company told KPMG: “Every year 25% of our business is eaten away by counterfeits. In a fair playing field the government should take care of this.”
One of the reasons often given for entering into a JV is that it gives instant access to local workforce and management. However, the report argued that availability of labour is now one of the areas of least concern for consumer market companies.
“With employee attitudes and the ability to attract expatriates also rated as being of little concern, it becomes clear that the need to buy into an existing workforce is much diminished from what it was,” KPMG says.
Baillache said: “Many businesses coming to China have had some pretty bad experiences when engaging in JVs. Successful JVs are the exception, rather than the rule. The two partners may have similar short-term aims but we have seen plenty of cases where one side’s long-term aspirations were at odds with the other side’s. If the ready-made workforce aspect of the JV – one of the perceived key benefits – is no longer that important, then the appeal of the JV approach will surely fade further.”
The rise of the middle class
Another major factor promoting the expansion of foreign retail chains is the rise of the urban middle class in China. While the urban middle class included 17 million households in 2001, this has now risen to 39 million households. Foreign retailers, such as Carrefour, are faced with increasingly accessible, relatively affluent consumers, many of whom have increasingly western values and enjoy shopping in western-style stores.
One of the main problems foreign retailers encounter is competing with traditional wet markets for sales of fresh produce. Carrefour has recognised this problem and has placed a great deal of importance on the fruit and vegetable offering in its Shanghai stores. They contain a wide range of fresh produce, which is restocked several times a day. They also sell a range of organic fruit and vegetables, and offer pre-packaged vegetables like those found in many western supermarkets. Carrefour’s stores have full-service deli counters and in-store bakeries, and even offer fresh fish, turtles and frogs.
Aside from fresh food, the stores also offer a wide range of other foods and have an extensive non-food offering. There are very few western brands on offer; instead shoppers can choose between a large number of local brands and the company’s own private label goods. The labels on Carrefour’s own private label brand, Carrefour Product, display information in both English and Chinese, and the line enjoys a good level of acceptance from consumers.
The importance of convenience
As in many European cities, the demographics of urban China increasingly favour modern convenience store formats, rather than supermarkets and out-of-town hypermarkets. In cities such as Shanghai there is a predominance of single-person households, and amongst the dense population of urban centres many people live in small, high rise apartments with limited storage space, so people are more likely to favour top-up shopping rather than once-a-week supermarket shopping or bulk buys. Furthermore, a large proportion of people walk to the shops, meaning they can only buy what they can carry.
As for families, China is experiencing a rapid increase in working women, changing the traditional family demographic and meaning women who normally do the shopping and cooking for the family are finding they have little time for either. This has also contributed to a rise in the frequency of family meals eaten outside the home. All this means that many urban consumers are increasingly putting more importance on convenience than they are on the range of products on offer. One downside of this for retailers is the phenomenal cost of good quality retail space in top-tier cities such as Shanghai and Beijing.
Whereas in the US the modern convenience store concept is well established, having been around since the 1970s, the concept is relatively new in China. Before the 1980s there was very little choice of retail outlets besides government-controlled supply stores. In the 1980s department stores came into being, followed by supermarkets, clubs and warehouses, and then hypermarkets in the mid-1990s. The modern convenience store concept has only really started to make an appearance in China in the last few years, but could become increasingly popular especially as urban populations grow.
Tesco in China
With international retailers showing such a high level of interest in the Chinese market, Tesco’s announcement last week came as no surprise. The company had made no secret of its plans to enter the Chinese market, with chairman David Reid telling a recent IGD conference that most international retailers are interested in China because of the huge market potential. Reid said then that although Tesco wanted to be in China, it would need to be sure it had the right model for entry.
When asked whom he most admires when it comes to retail in China, Tesco’s Reid picked out France’s Carrefour, for entering the market early and making a success of its move. He also said Carrefour’s success there is encouraging, proving that the consumer market is there and ready for foreign retailers.
Reid was also asked about other emerging markets, and did not seem as keen on entering markets such as Russia and India compared to China. Russia has always been high-risk, Reid said, although there are signs that it is improving and less volatile than before. It seems it is still early days for Tesco regarding a possible entry into Russia. As for India, Reid pointed to obstacles such as the closed nature of the market, where a foreign retailer cannot have a controlling stake, and difficult bureaucracy.
With its changing demographics, shifts in regulation and changes in consumer behaviour, China is considered by many international retailers to have huge potential for growth. But as with any international expansion, the need to get the format right is of the utmost importance. Whether foreign retailers like Tesco can continue to take advantage of this growth and realise the market potential remains to be seen.
